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Explaining the recent selloff in Spanish bonds is easy: The bond market has finally come to grips with the idea there is no solution for Spain’s massive structural problems. Here is a trio of articles to show what I mean.
Spanish Banks Stuck ‘Unsellable’ Real Estate, 50% of Real Estate Loans are Troubled
Bloomberg reports Spanish Banks Have $41B of ‘Unsellable’ Real EstateSpanish banks, under pressure to cut property-backed debt, hold about 30 billion euros ($41 billion) of real estate that’s “unsellable,” according to a risk adviser to Banco Santander SA (SAN) and five other lenders.
“I’m really worried about the small- and medium-sized banks whose business is 100 per cent in Spain and based on real- estate growth,” Pablo Cantos, managing partner of Madrid-based MaC Group, said in an interview. “I foresee Spain will be left with just four large banks.”
Spanish lenders hold 308 billion euros of real estate loans, about half of which are “troubled,” according to the Bank of Spain. The central bank tightened rules last year to force lenders to aside more reserves against property taken onto their books in exchange for unpaid debts, pressing them to sell assets rather than wait for the market to recover from a four- year decline.
Land “in the middle of nowhere” and unfinished residential units will take as long as 40 years to sell, Cantos said.
Land in some parts of Spain is literally worthless, said Fernando Rodriguez de Acuna Martinez, a consultant at Madrid- based adviser R.R. de Acuna & Asociados.
“If there were to be a proper mark to market of real estate assets, every Spanish domestic bank would need additional capital,” said Daragh Quinn, an analyst at Nomura Holdings Inc. in Madrid, in a telephone interview.
‘Enormous’ Price Gap
There is an “enormous” gap between prices offered by banks and what investors are willing to pay, preventing sales of large property portfolios, MaC Group’s Cantos said.
“Banks have already provisioned for a 30 per cent loss, but if you are selling at 70 per cent discount, you have to take another 40 per cent loss. Which small and medium size banks can take such a hit?”
Wave of Debilitating Defaults in Subordinate RMBS Tranches
Reuters comments on Default pain in Spain RMBS
Extremely poor performance of assets in Spanish RMBS, which in some cases means there is simply not enough performing collateral in the portfolios to service required cashflows, could lead to a wave of debilitating defaults in subordinate tranches.
Eurozone’s Weaker Link
The BBC reports Spain Becomes Eurozone’s Weaker Link
Yesterday, when Spain actually borrowed €3.6bn of new 10-year loans, it had to pay 6.975%, the highest rate for 15 years and so close to the unaffordable 7% rate as makes no helpful difference.
In short, as Spain prepares for its general election on Sunday, it has become the weaker link in the eurozone chain. New fundamental research by the consultancy McKinsey sheds some light on why that should be.
The point is that if you add together all debts – government debts, corporate debts, financial institution debts, and household debts – Spain is a much more indebted or leveraged country than Italy.
In general Spanish businesses geared up, or took on huge amounts of additional debt, especially those in the property and utility sectors.
The indebtedness of households rose to 82% of GDP, government debt increased to 71% of GDP and financial debt – which is bank lending to financial vehicles that aren’t banks – went up to 76% of GDP.
Italy’s government debts, at around 120% of GDP, are a far bigger burden than Spain’s.
And the debts of its financial sector are more or less the same: which may be another way of explaining why creditors’ confidence in both Italian and Spanish banks has been seeping away in recent weeks and months.
But the debts of Italy’s private sector are a fraction of Spain’s. The indebtedness of Italian businesses is just 81% of GDP and the indebtedness of households just 45% of GDP. Italy’s private sector, from the point of view of indebtedness, is in pretty good shape.
So Italy’s total indebtedness at the end of last year was 313%, some 50 percentage points less than Spain’s.
The point is that a government’s ability to service and repay debts depends partly on the overall size of the debts, and partly on the health of the private sector that pays taxes.
A private sector relatively burdened by huge debts – as is the case in Spain but not Italy – is less able to spend and invest. As a result, it struggles to provide the momentum in the economy necessary for the generation of growing tax revenues.
With 22% unemployment and a hugely over-burdened private sector, the bond market has finally caught on that austerity measures are not going to help Spain meet its budget goals.
A new government will be elected this weekend in Spain. Will it raise taxes? Collect more revenue?
It’s the latter that is important, and that is mission impossible.
Mike “Mish” Shedlock
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